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Why is external competitiveness important in compensation?

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External competitiveness is important in compensation because it helps employees get fair compensation. As long as a business knows that there is another firm willing to pay a worker more for their services, they will adjust the salary accordingly. The corporation will try as much as possible to match the compensation offered by other employers in the market so as to attract and retain the best workers. If the company cannot offer the same benefits as their competitors, they will give the employee non-financial incentives.

Why salaries are competitive?

In a competitive market, firms cannot afford to lose their best workers because it will affect their profitability and output. For example, if a company wants to hire a new worker, it has to create a budget for recruitment and training. To avoid such inconveniences, the company prefers to do its best to please the current employees.

Competition also helps new businesses know the market wage rate. If a market has two or three players, it may be difficult for a new firm to know how much workers are paid. Without such information, new businesses wouldn’t know how much to give their employees in order to retain them. As a result, these firms could end up overpaying or underpaying their workers. Therefore, the competition allows new firms to compensate employees fairly and reduce the turnover rate.

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External competitiveness is an important part of compensation for several reasons.

First, it behooves employers to know what the market rate is for their employees and what local competitors are paying for the same positions. This helps them gauge where their company fits into the overall compensation structure of the industry and strategize how to both sell their company to new hires and retain current employees.

Second, external competitiveness can dictate internal changes. If, for example, an employer learns that companies A and B have improved their compensation packages (salary plus benefits), the employer might feel compelled to make a similar change, fearing that word of the changes will reach his or her employees. Conversely, if competitors lower compensation, an employer might want to raise his to attract new workers.

Third, external competitiveness provides a degree of accountability. When competitors' compensation packages are known, executives can use that data to compare financial figures and better determine how the company is performing vis-à-vis its peers—kind of like being able to look at baseball standings and see if you're in first place or fourth. Company leaders can factor compensation into other financials, such as revenues and profit margins, to get a clearer picture of competitors' structures and of their own.

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The first important element of external competitiveness is how it affects the the quality of the candidate pool for job openings. In industries such as engineering or AI, where talented people have many different employment options, or for mission critical positions such as CEO or CFO, the best workers have a choice of many positions and are unlikely to choose one that pays significantly less than other opportunities. Moreover, a low compensation package sends a message that the the potential position is not valued by the company.

Next, external competitiveness will reduce turnover. If employees realize that they can earn significantly more by working elsewhere, they will be sending out their resumes or being courted by headhunters. Not only is turnover expensive for a company but high turnover reduces productivity.

Even in the cases of less skilled employees, external competitiveness is still important for getting and retaining the best workers and motivating them to be committed to growing with company and always doing their best work.

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External competitiveness refers to an organization's pay as compared to its competitors. This pay is the compensation employees receive including the base pay, bonuses, perks, options, etc. and may also be known as CTC (cost to company) in some countries.

Compensation is actually decided by (among other factors) how competitive an organization wishes to be with respect to its competitors. In other words, an organization will need to pay market average or higher than market average compensation to attract talent and retain it. A better compensation package will help an organization employ brighter talent who would be less willing to leave and would be more productive than the talent willing to work at lower compensation package (and may be more amenable to turnover). The compensation is also affected by forces of demand and supply, among other factors. In some case, perks like work-life balance may be used to attract the talent, such perks are part of the compensation package. 

Note that a higher compensation package will increase the labor cost and that has to be factored in, by the managers, while deciding compensation levels to stay competitive. So an organization may decide on lag (less than market), match (equal to market i.e., competitors) or lead (more than market average) type of compensation.

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